Monopolistic Competition

Chapter 17
Copyright 2001 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777.

The Four Types of Market Structure

Number of Firms?
Many firms
One firm Few firms

Type of Products?
Differentiated products
Monopolistic Competition

Identical products
Perfect Competition

Monopoly

Oligopoly

Tap water Cable TV

Tennis balls Crude oil

Novels Movies

Wheat Milk

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Types of Imperfectly Competitive Markets

Monopolistic
Many

Competition

firms selling products that are similar but not identical. a few sellers, each offering a similar or identical product to the others.

Oligopoly
Only

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Monopolistic Competition
Markets that have some features of competition and some features of monopoly.

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Attributes of Monopolistic Competition

Many

sellers Product differentiation Free entry and exit

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Monopolistic Competitors in the Short Run...

(a) Firm Makes a Profit
Price

MC

ATC

Price Average total cost

Profit

Demand

MR
0 Profitmaximizing quantity Quantity

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A Monopolistic Competitor in the Long Run...

Price

MC
ATC

P=ATC

MR
0 Profit-maximizing quantity

Demand Quantity

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Monopolistic versus Perfect Competition

There are two noteworthy differences between monopolistic and perfect competitionexcess capacity and markup.

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Excess Capacity
There

is no excess capacity in perfect competition in the long run. Free entry results in competitive firms producing at the point where average total cost is minimized, which is the efficient scale of the firm.

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Excess Capacity
There

is excess capacity in monopolistic competition in the long run. In monopolistic competition, output is less than the efficient scale of perfect competition.

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Excess Capacity...
(a) Monopolistically Competitive Firm Price MC ATC (b) Perfectly Competitive Firm MC Price ATC

P Excess capacity Demand

P = MC

P = MR (demand curve)

Quantity Efficient produced scale

Quantity

Quantity= Efficient produced scale

Quantity

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Markup Over Marginal Cost

For

a competitive firm, price equals marginal cost. For a monopolistically competitive firm, price exceeds marginal cost.

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Markup Over Marginal Cost

Because price exceeds marginal cost, an extra unit sold at the posted price means more profit for the monopolistically competitive firm.

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Markup Over Marginal Cost...

(a) Monopolistically Competitive Firm Price Markup (b) Perfectly Competitive Firm Price

MC

ATC

MC

ATC

P = MC
Marginal cost

P = MR

(demand curve)

MR

Demand Quantity Quantity

Quantity produced

Quantity produced

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Monopolistic versus Perfect Competition...

(a) Monopolistically Competitive Firm Price Markup (b) Perfectly Competitive Firm Price

MC

ATC P = MC

MC ATC P = MR

Marginal cost

(demand curve)

MR
Quantity produced Efficient scale

Demand Quantity
Quantity produced = Quantity Efficient scale

Excess capacity
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Advertising
When firms sell differentiated products and charge prices above marginal cost, each firm has an incentive to advertise in order to attract more buyers to its particular product.

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Advertising
Firms

that sell highly differentiated consumer goods typically spend between 10 and 20 percent of revenue on advertising. Overall, about 2 percent of total revenue, or over $100 billion a year, is spent on advertising.

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Advertising
Critics

of advertising argue that firms advertise in order to manipulate peoples tastes. They also argue that it impedes competition by implying that products are more different than they truly are.

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Advertising
Defenders

argue that advertising provides information to consumers They also argue that advertising increases competition by offering a greater variety of products and prices. The willingness of a firm to spend advertising dollars can be a signal to consumers about the quality of the product being offered.
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Brand Names

Critics

argue that brand names cause consumers to perceive differences that do not really exist.

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Brand Names
Economists

have argued that brand names may be a useful way for consumers to ensure that the goods they are buying are of high quality.
providing

information about quality. giving firms incentive to maintain high quality.

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